3/06/2009 @ 5:20PM

Safest Money Funds Shuttered

Some of the nation’s largest mutual fund firms, including Vanguard, Fidelity Investments and
Charles Schwab Corp.
, are closing their safest money market funds at the time when investors are ravenous for security. All three firms have taken similar steps in recent weeks to close Treasury money market funds to new investments.

The $40 million pension fund for the Orange County Sheriff’s Office in Orlando, Fla., once invested in the Vanguard Treasury Money Market fund because it was considered risk-free. The fund is fully invested in short-term securities backed by the full faith and credit of the U.S. government.

Yet the worldwide financial crisis has dropped the yield on the T-bills the fund owns to close to zero. In February, the fund returned only 0.02% net of expenses, which is far below the 0.28% expense ratio that it charges.

In a February letter to investors in some of its 401(k) plans, Vanguard blamed the low yields offered by Treasuries for the closure, stating that its Treasury Money Market Fund would accept no new contributions beginning Feb. 27. Past contributions are allowed to remain in the Treasury fund.

However, customers who fail to change their new contribution allocations themselves will have their funds redirected to the Vanguard Prime Money Market fund.

“Vanguard Prime Money Market Fund has an identical investment objective to Vanguard Treasury Money Market Fund: It seeks to provide current income while maintaining liquidity and a stable share price of $1. However, Vanguard Prime Money Market Fund has a higher seven-day yield,” according to a letter sent to 401(k) participants.

An identical investment objective does not mean the funds are equally safe, argues Edward Siedle, president of Benchmark Financial Services and a consultant to the Orange County Sheriff’s plan.

“I believe it’s misleading to simply say the Treasury and the Prime Money Market funds have the same investment strategy but fail to disclose that the risks involved are entirely different,” he says.

A spokesman for Vanguard said that the letter to investors made clear that the funds invest in different securities.

“It’s pretty clear that government funds are different from prime funds,” said John Woerth, a Vanguard spokesman. “There is a marginal difference in safety. Prime is a very high-quality, well-managed fund that has half of its assets in government securities.”

Though every money market fund attempts to maintain a share price of $1, individual funds go about this in different ways. The Vanguard Prime Money Market fund, for example, has 37% of its assets in certificates of deposit and 12% in commercial paper, the type of short-term loans that banks and institutions typically issue for daily cash flow. About half of the fund is invested in U.S. government debt.

Siedle believes the portion of the fund that is not in government debt is subject to substantially greater risk. “You’re scared, you’ve been thrown out of a Treasury fund and are being forced into a fund that more likely than not is going to take some hits,” he said. “For Vanguard to deny investors a safe heaven at a time of unprecedented market turbulence, and to steer them into a far riskier fund, is no way treat loyal customers.”